Rajan offers emerging economies the mantra for growth

Multilateral institutions like the IMF need to re-examine 'rules of the game' but central banks should not ignore international responsibilities despite their domestic mandates, RBI Governor Raghuram Rajan has said.

Rajan, in his address to the Economic Club of New York on Tuesday, made a strong case for the IMF to analyse each new unconventional monetary policy, including sustained unidirectional exchange rate intervention. Rajan said based on their effects and the agreed rules of the game, the IMF should declare them ‘in or out-of-bounds.’

"We also need better international safety nets.

“And each one of us has to work hard in our own countries to develop a consensus for free trade, open markets and responsible global citizenry," he said.

"If we can achieve all this even as recent economic events make us more parochial and inward-looking, we will truly have set the stage for the strong sustainable growth we all desperately need," the RBI Governor said.

Rajan stressed that central banks should not ignore international responsibilities despite their domestic mandates.

"The bottom line is that multilateral institutions like the IMF should re-examine the 'rules of the game' for responsible policy and develop a consensus around new ones.

“No matter what a central bank's domestic mandate, international responsibilities should not be ignored," he said.

Rajan said with authorities in almost every industrial country focused on appeasing populist anti-trade anti-finance and anti-central bank political movements, there is little appetite for taking on further international commitments.

He said a big factor persuading authorities in industrial countries to push for higher growth is the fear of deflation.            

Noting that deflation increases the real burden of existing debt, Rajan said if debt is excessive, a targeted restructuring is better than inflating it away across the board.

". . .the spectre of deflation haunts central bankers.

“When coupled with the other political concerns raised by slow and unequal growth. . .it is no wonder that the authorities in developed countries do not want to settle for low growth, even if that is indeed their economy's potential," he said.

The former IMF chief economist said the central dilemma in industrial economies has been how to reconcile the political imperative for strong growth with the ‘reality that

cyclical stimulus measures have proved ineffective in restoring high growth, debt write-offs are politically unacceptable and structural reforms have the wrong timing, politically speaking, of pain versus gain."

Rajan said unconventional monetary policies include both policies where the central bank attempts to commit to hold interest rates at near zero for long, as well as policies that affect central bank balance sheets such as buying assets in certain markets, including exchange markets, in order to affect market prices.

Further, emerging economies also have to work to reduce vulnerabilities in their economies so that they can allow exchange rate flexibility to do much of the adjustment for them to capital inflows, Rajan said.

"But the needed institutions take time to develop.

“In the meantime, the difficulty for emerging markets in absorbing large amounts of capital quickly and in a stable way should be seen as a constraint, much like the zero lower bound, rather than something that can be altered quickly.

“Even while resisting the temptation of absorbing flows, emerging markets will look to safety nets," he said.

Rajan said the current non-system in international monetary policy is a source of substantial risk, both to sustainable growth as well as to the financial sector.

"It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action.

“We are being pushed towards competitive monetary easing and musical crises," Rajan said.

"I use depression-era terminology because I fear that in a world with weak aggregate demand, we may be engaged in a risky competition for a greater share of it. We are thereby also creating financial sector risks for when unconventional policies end," he said.

Rajan pointed out that there is need for stronger well-capitalised multilateral institutions with widespread legitimacy, some of which can provide patient capital and others that can monitor new rules of the game.